Understanding The Basics of REITs

Why were REITs created?

Congress created REITs in 1960 to make investments in large-scale, income-producing real estate accessible to average investors. Congress decided that a way for average investors to invest in large-scale commercial properties was the same way they invest in other industries — through the purchase of equity. In the same way shareholders benefit by owning stocks of other corporations, the stockholders of a REIT earn a pro-rata share of the economic benefits that are derived from the production of income through commercial real estate ownership. REITs offer distinct advantages for investors: portfolio diversification, strong and reliable dividends, liquidity, solid long-term performance and transparency.

What is a REIT?

A REIT, or Real Estate Investment Trust, is a company that owns or finances income-producing real estate. Modeled after mutual funds, REITs provide investors of all types stable income streams, diversification and long-term capital appreciation. REITs typically pay out all of their taxable income as dividends to shareholders. In turn, shareholders pay the income taxes on those dividends.

REITs allow anyone to invest in portfolios of large-scale properties the same way they invest in other industries – through the purchase of stock. In the same way shareholders benefit by owning stocks in other corporations, the stockholders of a REIT earn a share of the income produced through real estate investment – without actually having to go out and buy or finance property. Learn more.

How does a company qualify as a REIT?

In order for a company to qualify as a REIT, it must comply with certain provisions within the Internal Revenue Code. As required by the Tax Code, a REIT must:

  • Be an entity that is taxable as a corporation
  • Be managed by a board of directors or trustees
  • Have shares that are fully transferable
  • Have a minimum of 100 shareholders
  • Have no more than 50 percent of its shares held by five or fewer individuals during the last half of the taxable year
  • Invest at least 75 percent of its total assets in real estate assets
  • Derive at least 75 percent of its gross income from rents from real property or interest on mortgages financing real property
  • Have no more than 25 percent of its assets consist of stock in taxable REIT subsidiaries
  • Pay annually at least 90 percent of its taxable income in the form of shareholder dividends

How many REITs are there?

As of Sept. 30, 2015, there were 199 REITs listed on the New York Stock Exchange. These REITs have a combined equity market capitalization of $847 billion.

Additionally, there are REITs that are registered with the SEC but are not publicly traded, and REITs that are not registered with the SEC or traded on a stock exchange. Internal Revenue Service shows that there are about 1,100 U.S. REITs that have filed tax returns.

What Types of REITs are there?

The REIT industry has a diverse profile, which offers many investment opportunities. REITs often are classified in one of two categories: equity or mortgage.

Equity REITs:
Equity REITs mostly own and operate income-producing real estate. They increasingly have become real estate operating companies engaged in a wide range of real estate activities, including leasing, maintenance and development of real property and tenant services. One major distinction between Equity REITs and other real estate companies is that a REIT must acquire and develop its properties primarily to operate them as part of its own portfolio rather than to resell them once they are developed.

Mortgage REITs:
Mortgage REITs mostly lend money directly to real estate owners and operators or extend credit indirectly through the acquisition of loans or mortgage-backed securities. Today's Mortgage REITs generally extend mortgage credit only on existing properties. Many mortgage REITs also manage their interest rate and credit risks using securitized mortgage investments, dynamic hedging techniques and other accepted derivative strategies.


Who manages a REIT?

Like other publicly traded companies, a REIT's executive management team operates the company, deciding what properties it will own and manage. Management's decisions are overseen by a board of directors that is responsible to the shareholders. As with other corporations, REIT directors are typically well-known and respected members of the real estate, business and professional communities. Many of today's REITs became public companies within the past 20 to 25 years, often transforming to public ownership what previously had been private enterprises. In many cases, the majority owners of these private enterprises became the senior officers of the REIT and contributed their ownership positions to the REIT.

What types of properties do REITs own and manage?

REITs own and manage a variety of property types: shopping centers, health care facilities, apartments, warehouses, office buildings, hotels and others. Most REITs specialize in one property type only, such as shopping malls, timberlands, data centers or self-storage facilities.

Some REITs invest throughout the country or in some cases, throughout the world. Others specialize in one region only, or even in a single metropolitan area.



How are REITs different from partnerships?

REITs are not partnerships. Most publicly traded REITs are vertically integrated real estate companies that develop, own and actively manage commercial real estate. Shares in these companies are traded, the same as other stocks, on major exchanges, providing complete liquidity and market pricing. Publicly traded REITs are subject to the same financial disclosure requirements as other publicly traded companies. Independent corporate governance consultants have rated the REIT industry's governance among the best of all U.S. industry groups.